TECHNOLOGY, ECONOMIC INTEGRATION AND SOCIAL COHESION

TECHNOLOGY, ECONOMIC INTEGRATION AND SOCIAL COHESION Executive summary of project ERB-SOE1-CT-95-1005 Funded under the Targeted Socio-Economic Research (TSER) programme Directorate General XII Science, Research & Development/Directorate F EUROPEAN COMMISSION February 1996 August 1999 Coordinator of Project Dr. Bart Verspagen MERIT Tongerstraat 49 NL 6211 Maastricht (The Netherlands) Fax : 31 :43 388 22 22 E-mail : bart.verspagen@merit.rulimburg.nl Partners Science Policy Research Unit (SPRU), United Kingdom Universidad Complutense de Madrid, Spain FIEF, Sweden IKE-GROUP, Denmark STOA, Italy CEPREMAP, France CEDI, France IDEGA, Spain NUPI, Norway South Bank University, United KIngdom 1

1. EXECUTIVE SUMMARY This project aims to provide insight into the impact of two important and interrelated developments in the world economy on social cohesion and exclusion in the European Union. These developments are: (i) technological change, and in particular the so-called called Information and Communication Technologies (ICTs); and (ii) globalisation, broadly driven by technology and by the liberalisation and deregulation of trade and capital flows. Technology (ICTs) is seen as the single most important factor shaping employment and economic growth, while globalisation is seen as leading to qualitative changes in the form and effects of the exposure of countries to foreign competition. Social cohesion is a broad issue with many different aspects. An important part of the concept of social cohesion relates to (un)employment and income differences. The project aims to focus mainly on these two issues when dealing with the issue of social cohesion. The level of analysis is the country and the regional level, both within the European Union. The project also aims to compare European Union performance to the global economic trends. The project uses a mix of methodologies from economics and business studies, including descriptive data analysis, economic model building, econometric analysis and policy analysis to analyze the impact of technological change and globalisation on social cohesion in the European Union. There is an ongoing debate about the factual evidence surrounding globalisation. Most of the readily available evidence, presented in many OECD and European Union reports, focuses on trade and foreign direct investment (FDI) flows. This evidence tends to suggest that there has been little increase in globalisation defined in this way. Viewed in this narrow way, globalisation may indeed be considered a myth. However, such a view ignores at least two important aspects of current developments: the structure (i.e., sectoral and national shares) of the FDI and trade flows, and the vehicles (e.g., institutional change and technological change) for the increase of these flows. It will be argued here that with regard to both these aspects, crucial new developments are taking place, and that these have important implications for issues under research in this project. These structural changes with regard to international trade include four trends: 1. The dominant expansion of trade flows within regions following the development of regional integration processes. As the European Union intensified with the single act and the monetary union, regional arrangements developed in North and South America (respectively NAFTA and MERCOSUR), but also in South East Asia and around the Pacific Rim (respectively the ASEAN and APEC agreements). A feature common to these regional arrangements is that they all boosted intraregional trade flows. 2. The increase in intra-industry trade, which accompanied the rise in intra-regional trade flows within Europe and North America. On the one hand, intra-industry trade may be the result of horizontal product differentiation, i.e. a growing international mix of product brands. Increased economic development, as well as economic integration, favours this diffusion of a wider spectrum of products. On the other hand, intra-industry trade may follow from quality specialisation among partner countries, i.e., vertical product differentiation. 2

3. The internationalisation of service markets reflects a third recent structural change in trade flows and can be interpreted as a major part of the new phase of globalisation. 4. Changes in the directions of trade flows between regions are a further important structural development of international trade in goods and services. The share of South East Asia in the trade of the US or of Japan nearly doubled between 1970 and 1993. But while imports and exports of this zone with the European Union were rather balanced, they led to a marked trade deficit for the US and to a net surplus for Japan. In comparison, trade flows between the triad and the east-european economies remained modest. Similar to the case of international trade, the structure of recent FDI, in terms of sectors and countries, seems to be more telling of a new fabric of international relations than its increasing volume. The most important changes we see include : 1. An important characteristic of this industrial investment is the rapidity with which it reacted to a change in context, and, hence, the direction of FDI, by country and sector, is telling of the actual restructuring strategies of firms in the international context of each sub-period. 2. Globalisation activities of firms appear no longer simply a question of globalising sales with accompanying services such as marketing, distribution and after-sales service. FDI now involves to a great extent production, including production by component suppliers, intangible investment, mergers and acquisitions, partnerships, so-called strategic alliances, etc. The aim of firms is increasingly directed towards global presence strategies. Such strategies aim at finding a balance between reaping some of the scale advantages of global markets associated with intangible assets, while also exploiting the often geographically determined diversity of consumers and production factors. 3. FDI may generate important externalities or spillovers to the local environment. The often scarce and sometimes geographically immobile factors that are affected by this contribute to creating the increasing returns growth features of long-term development. This raises the issue of the relationship between firms and the national environment, and thereby the meaning of many national policies. The common denominator behind the emergence and development of most of these trends is the widespread use of information and communication technologies. Deregulation, as an important factor behind globalisation, is in the first place a consequence of the diffusion of new information and communication technologies (ICTs) which, in easing international access and provision, helped firms to bypass the limitations set by the old national regulatory frameworks. We thus see the world economy undergoing two major structural changes during the last decades: increased globalisation of the world economy, and a strongly increased role of (technological) knowledge, mostly in the form of ICTs. These trends must be placed into the historical context of the role of Europe in the world economy, and the changes to this role resulting from the process of European integration since the 1950s. The phase of catching-up of Europe and parts of Asia to the United States in the 1950s and 1960s was made possible by increased international trade in this period, 3

as well as European integration, which led to an increase of market size in Europe. However, while Europe, Japan and other countries started to catch up in many typical American way of life products, US industry leaped forward in another area, that of science-based industry, in part due to massive public investments in R&D during the Second World War and the cold war that followed. Thus, while Europe was trying to complete its catching-up process, another institutional and technological change was set in motion in the US economy. With hindsight, one may indeed say that this trend towards increased science-based growth was the beginning of the knowledge economy. When looking at the world product markets (international trade) since 1970, Japan and the Asian NICs gained market shares at the expense of the USA and Europe. In particular, the Asian NICs showed a spectacular performance; between 1970 and 1995 their overall market share increased more than five times. It is also noteworthy that the rapid growth of Japan and the Asian NICs was accompanied by very rapid structural changes that totally changed the specialisation pattern of these countries. In contrast to the Asian experience, both Europe and the USA lost overall market shares. Moreover, these losses were generally more manifest in high-technology sectors, particularly science-based industries, than elsewhere. As a consequence, in the 1990s Europe was no longer specialised in science-based industry. European integration has favoured natural resource-based and scale-intensive industries, and this is consistent with the observed change in its pattern of specialisation. However, given that modern growth is increasingly knowledge-based, it seems relevant to ask to what extent this move away from the technologically most advanced and fast-growing parts of manufacturing poses a problem for Europe s future growth and welfare. Within Europe during the 1960s and 1970s, the tendency for European countries to catch up with the US also translated into a tendency for differences in GDP per capita within Europe to become less pronounced. This process of convergence took place between countries as well as between regions within countries. However, from the beginning of the 1980s, convergence halted or became much slower than before, especially at the regional level. The project finds that these trends can clearly be related to the increasing importance of knowledge in the economy. Although the increasing openness of European countries certainly increased their ability to absorb knowledge from abroad, the analysis shows that important barriers to knowledge spillovers between European regions remain. Most importantly, geographical distance, country borders (or rather, the differences in national culture and languages they embody) and differences in the level of development between regions all hinder the free flow of knowledge. The worries about the lack of competitiveness of Europe in the knowledge economy readily translate to the issue of employment. Technology has become regarded as a major force behind job creation and a central concern behind the high unemployment rates in Europe. The rapid introduction of new technologies, spurred by Europe s own integration process and the broader globalisation process, has often been singled out as one of the main factors behind widespread job losses in individual industries or among workers with particular skills in many European countries. They are also held responsible for increased wage and income disparities and work insecurity. At the same time, politicians, at both national and European level, businessmen and many technology experts and economists continue to 4

have great expectations with respect to the long-term growth and employment creation potential of new technologies, particularly ICTs. These expectations are built partly on the historical record of the overall positive employment impact of previous waves of technological change and partly on the special features of present ICTs. However, the growing concerns about the employment and distributional implications of contemporary technological change are, as has been emphasised by many economists for centuries, not really based on any historical precedents. The analytical line pursued in this project insists on the learning processes that are associated with a number of broad contemporary structural changes. In addition to globalisation and the rise of the knowledge economy, this also includes the rise of business services as the latest phase of a long-run trend of tertiarisation of the developed economies. Together these three factors led to an increased level of uncertainty for economic agents making decisions in a world both rapidly changing, and where the standard of competitiveness has been steadily rising. This raises complex issues of internal and external organisation of firms, which on its turn affects the dynamics of employment in many ways. This manifests itself, for instance, in terms of new relationships between firms, and new skill requirements within firms. The demand by firms for employment concentrates on labour that is more flexible, more skilled, and more adaptable to new qualification requirements. The underlying causal relationships at work have been not been addressed much in the debates around this issue. This is why the contributions to this project have mostly focused on the underlying complexity between the demand for various categories of qualifications, technological change and international competition. Summarising the work in this area of work organisation and skills, the analysis suggest on various accounts that education, or more broadly, issues of labour supply, have a major impact on employment trends. This leads us to analyse the impact of institutional change implied by the transformation of educational systems and broader institutional context influencing the quality of the labour force and its participation rates. In the institutional field, the analysis focused on three issues. One is concerned with the social organisation of working time, which is obviously a main dimension in the organisation of labour markets. A second has to do with the evolution of national systems of innovation, in particular the role they play in the provision of proper human resources. Third, we tried to link our preoccupations on institutional matters with the questions on the future of the welfare state. With regard to the issue of FDI, the object has been to get a better understanding of the role of FDI, international mergers and acquisitions and TNCs in European integration, as well as the priority given by such firms respectively to their operations in the Union and at the broader level of the Triad and the global economy. Here we find supporting evidence for a further tertiarisation of the economy. At least half of foreign investment, and in some cases a much higher proportion, takes place in service industries. Finance, insurance and business services accounted for the largest part for many countries, but telecommunications and public utilities have become important in the wake of deregulation and/or privatisation. Also, mergers and acquisitions (M&As) represent a very high percentage of FDI. In 1998, the share of M&As in total OECD outward and inward FDI was over 90%. 5

Both inward FDI by firms from countries outside the Union and intra-regional FDI have had tradeinducing effects. This has been mainly aimed at exploiting the potentialities of large host economies or that of the European Union as a Single Market. Exports have been largely concentrated within Europe and have contributed to the strong inward-looking bias of European trade. European trade is characterised by particularly high levels of intra-regional exports and imports, giving European trade a stronger inward-looking bias than is the case for the intra-regional concentrations of trade at the other two poles of the Triad. The analysis shows that the changes associated with the shift towards a knowledge-dominated economy (such as pervasive ICTs, globalisation and the advent of new forms of activity), and the far-reaching restructuring that is going on, call for a concerted policy response. One of the main challenges facing policy is how to deal with the apparently adverse specialisation pattern of European industry documented in this project. A major policy issue here is the extent to which it is desirable to target the expansion of these areas, which offer good potential for growth, especially if they are employmentfriendly. Past policy errors have resulted in such targeting falling out of favour. However, one of the threads running through this research is that a new technological paradigm based on ICTs is emerging, and in the light of this, it makes sense to look afresh at the case for explicit targeting. Responding to ICT as a new techno-economic paradigm calls for a reassessment of the factors that influence capabilities in this area. The work in this project stresses the importance of transforming the education and training systems in order to equip individuals with the skills needed for an environment in which the major new technology is pervasive. The continuing skill shortages in software testify to the relative failure of Europe to meet this challenge, and it is evident that this deficiency has slowed the diffusion of ICTs beyond the immediate sectors that developed and applied them. The project also emphasises the importance of combining skills with diffusion-oriented policies centred on social needs, in order to stimulate learning processes. In this regard there is great scope for raising quality as the core competitive advantage. Both product and product innovation can assist in achieving this aim and it is clear that this should be another policy priority. The project discusses a number implications for different policy areas at the European level. With regard to macroeconomic policy, it is suggested that the EU economy is now well-placed to adopt a more expansionary economic policy. The key point, however, is that a policy framework in which decisions affecting the demand-side are taken without considering the supply-side will be less effective. With regard to the regulatory system, it is argued that especially in the emerging areas of ICTs and biotechnology, the early adoption of appropriate standards and the manner in which regulations are framed can have a crucial impact on the pace at which the industries develop. It is our contention that Europe needs to adopt a wider and more inclusive definition of science and technology policy than in the past. EU sponsored Framework Programmes have played a useful part in financing and encouraging specific scientific research. Little effort has, however, gone into promoting capability amongst users of ICTs and in providing a social and institutional setting that encourages their implementation. 6

In the field of territorial policy, new plans will have to be devised very soon for the next Structural Funds programming period, running from 2000 to 2006. The project argues that much greater weight should be accorded in these plans to equipping the lagging regions to compete in the knowledge-driven economy. It is clear that there are only limited opportunities to foster activity in some of the leading knowledge sectors. At best, the EU can sustain only a handful of Silicon Valley equivalents, and there is little point in pretending otherwise. Instead, the challenge for policy-makers involved in territorial policies is to identify niches (processes, stages of production, products or services) where the region or locality can plausibly compete. With regard to labour market policies, the project suggests to follow a twin strategy of targeting those occupations or professions which support competitive advantage (e.g., in the the advanced service industries identified as central to economic growth) in order to boost economic growth, while having a separate strategy for job creation aimed at cutting unemployment. It is hard to avoid the conclusion that the bulk of new jobs must come from expansion of personal services in areas such as care. It is evident from the project that in responding to the challenges of the knowledge economy, many policy areas are asked to give directly or indirectly a significant contribution. Therefore, there is a need for more intra-european policy co-ordination both between different sector policies and across different territorial areas. In other words, important policy issues arise in determining the level at which policy shouldbeimplementedsoastobemosteffective. 7